Russian Energy Markets, the World Energy Markets and Russian Place in the World Energy Trade

Russia and the World Energy Markets: Long-term Scenarios Sergey Paltseva, John Reillya, and Natalia Tourdyevab aMassachusetts Institute of Technology (MIT), Cambridge, USA bCenter for Economic and Financial Research (CEFIR), Moscow, Russia Abstract: The paper focuses on energy markets in Russia. First, we look at the recent developments in the world energy markets and in Russian natural gas, oil, and electricity sectors. Then we consider different scenarios for a potential development of energy markets, both in Russia and in Russian trading partners. Using the MIT Emissions Prediction and Policy Analysis (EPPA) model, which is a general equilibrium model of the world economy, we consider different energy scenarios for the next 20-40 years. Our projections show energy use in Russia growing from 775 mtoe in 2005 to 1200 mtoe in 2050 in primary energy equivalence, while electricity use nearly doubles from about 1000 TWh in 2005 to 1900 TWh in 2050 in our reference projections. The energy system continues to rely heavily on traditional fossil energy. Our long-run reference projection for oil price is a continuous increase from $55/barrel in 2010 to $155/barrel in 2050 and for natural gas from $220/tcm in 2010 to $380/tcm in 2050. The model is not able to capture the volatility in energy prices that is commonly observed. The price projections should be seen as a long run trend around which there will likely continue to be volatility driven by short term events. Achieving the G8 goal of 50% greenhouse gas emissions reduction significantly changes our projections, reducing Russia’s fossil fuel production and domestic fuel and electricity use from the projected levels without such a policy. The paper is prepared for the GTAP 12th Annual Conference on Global Economic analysis to be held on June 10-12 in Santiago, Chile Contact: [email protected] 1. Introduction Russia is an important energy supplier. It holds the world largest natural gas reserves, the second largest coal reserves and the eighth largest oil reserves. Russia is also the world’s largest exporter of natural gas, the second largest oil exporter and the third largest energy consumer (EIA, 2008). Energy was one of the driving forces of Russia’s recent economic recovery From the economic collapse of 1990’s. The country enjoyed more that 5 percent annual real economic growth for the period of 2000-2008. The robust growth with ever increasing energy prices had contributed to a sense of a long-term economic stability in Russia. These prospects have changed drastically with a global recession, and the resulting reduction in a demand for fossil fuels, and the collapse of oil and energy prices. Most experts predict, or at least hope for, a recovery in the world economic activity by 2010. The global recession and potential recovery raises several questions: Will the recovery going to bring higher energy prices and increasing prosperity for energy-exporters? Or was the period of 2000-2008 a prolonged anomaly of higher than normal growth in Russia fueled by abnormally high energy prices? Is the current reduced demand for fossil fuels a temporary downturn or a new long-term trend in energy markets? In this paper we do not attempt to provide definite answers to these questions, rather we try to quantify some plausible scenarios for the future development. The goal of this paper is to analyze the potential scenarios for the Russian energy markets, the world energy markets and Russian place in the world energy trade. We use the MIT Emissions Prediction and Policy Analysis (EPPA) model (Paltsev et al., 2005), which is a computable general equilibrium model of the world economy. In this this study we preview a new version of the model that treats Russia as a separate region. The paper is organized in the following way. In Section 2 we briefly describe developments in global energy markets over the last 30-40 years with a particular focus on the situation in Russian natural gas, oil, and electricity markets. Section 3 presents the EPPA model used for the analysis and a reference scenario of Russian energy development up to 2050. In Section 4 we provide a projection where a carbon constraint is imposed on developed countries according to their G8 goal of greenhouse gas (GHG) emissions reduction by 50% relative to 2000 by 2050, where we consider different scenarios of Russian participation. Section 5 concludes. 2. Energy markets Russia has been a significant player in traditional energy markets of oil, natural gas, and coal. These energy sources are likely to remain dominant for years to come. At the same time, developed countries are in a desperate search for energy alternatives. There are several driving forces for this search: a sharp increase in energy prices in 2007-2008; concerns about climate change, where fossil fuel burning is one of the major contributors; and energy security considerations, where the U.S. and Europe remain uneasy about the power of energy-rich countries like Venezuela, Russia, Iran, and Saudi Arabia. Whether new energy alternatives can compete over the next few decades depends on the price of fuels and the policies that might create advantages for alternatives. Energy markets, like agricultural markets, seem to be subject to massive disruptions every 20 or 30 years, and it looks like we are in the midst of one of those disruptions. If we can understand where we are now and how we got here, then we may have some hope that we can understand where we are going. Will we see a repeat of the history of previous energy turbulence — what now looks different and what is similar? 2.1. World energy: the past 40 years The 1970’s was a period of turmoil in energy markets and of high energy prices. The proximate cause of high oil prices was first an oil embargo created by the Organization of Petroleum Exporting Countries (OPEC) in the early part of the decade followed up by the Iran-Iraq war and other tensions in the Middle East in the later part of the decade that also cut into supply, and caused another wave of price increases. As a response, energy importers introduced several initiatives focusing at energy alternatives. For example, the U.S. has created a new Department of Energy and a massive effort called Project Independence under which the plan was for the U.S. to supply all of its energy domestically. Under this plan there were efforts to demonstrate and produce synthetic fuel from vast U.S. resources of coal. There was also much interest in shale oil. Other initiatives of the time include the development of the Strategic Petroleum Reserve, Corporate Average Fuel Economy standards for vehicles, Federal excise tax exemptions for ethanol, natural gas price regulation, creation of a National Renewable Energy Laboratory to develop renewables, and research on fusion energy. While some of these initiatives may have been modestly successful, most of those projects and goals collapsed with the price of oil, and rather than the U.S. becoming energy independent, its dependence on foreign oil increased dramatically. In a large part, the collapse was due to the cancellation of large demonstration projects that were seen as a failure because the alternatives being developed under them were far more expensive than the now collapsed price of oil. Fusion power is still mostly a dream. Solar photovoltaics have found a role in places where grid connection is difficult but are not contributing a significant source of power. Wind energy appears closer to commercial competitiveness but the current success of these technologies is due to tax incentives and other subsidies that significantly lower the private sector cost, but this is paid instead by the taxpayer as a tax expenditure (lost tax revenue that must be made up with other taxes). And it is not clear that current wind costs fully address the variability of these generation sources through some type of storage or back-up. If the wind is not blowing on that hot August day when electricity demand is at its peak the system needs a kilowatt for kilowatt backup capacity unless there is large storage of some form somewhere. An excise tax exemption on ethanol has persisted, and created a viable ethanol industry but did not do much to bring along cellulosic production technologies. Basically, none of the exotic alternatives to conventional fossil fuels have really panned out yet in any significant way and so the 1970’s funding to develop them cannot be seen as responsible for lower prices in the 1980’s and 1990’s. Coincidentally, the events surrounding nuclear power, Chernobyl and 3-Mile Island accidents, have limited a construction of nuclear power plants for many years. If none of these things “solved” the energy crisis then what did? The 1970’s oil shocks caught energy markets off guard and we saw short-run run-ups because there was little flexibility. But with time, more conventional resources were brought on line. The lesson OPEC learned from the 1970’s and 1980’s was that pushing the price high in the short term would lead to its collapse and so they at least claim to seek price stability, trying to find that price that would generate revenue for them but that would not bring on alternatives or greatly reduce demand, collapsing the price and leaving them with little revenue. Much of the solution appears to have been due to reductions in demand. Energy use which had been growing each year flattened out through much of the 1980’s even with low prices and continued economic growth. Here debate remains with regard to how much of this was purely a response to the high prices (and expectations at least for a while that low prices were temporary) and how much was due to various regulatory programs to promote energy efficiency.

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